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Why you need to beware the Commodity Speculators

April 2, 2012

commodity speculatorsCommodity speculators often get a bad rap for manipulating the price of commodities that they trade in. Because the business of speculation isn’t well understood, it’s assumed that the speculators are causing the wild price fluctuations in the marketplace. It’s true. Speculators do buy and sell commodities for profit. Do they drive up the price of the underlying commodity? Sort of.

Recently, Starbucks chief Howard Schultz attacked hedge funds and commodity traders for driving up the price of coffee because he claimed the trading activity was “not based on supply and demand” but rather on speculation.

“Right now we are experiencing a very strange and almost inexplicable phenomenon in the commodities market. Without any real supply or demand issues we are witness to the fact that most agricultural food commodities are at record highs at once, and coffee is at a 34-year high,” said Schultz.

Schultz also said, “Through financial speculation – hedge funds, index funds and other ways to manipulate the market – the commodities market is in a very unfortunate position. This has resulted in every coffee company having to pay extraordinarily high prices for coffee.”

Coffee isn’t the only commodity seeing increases. BMW is also complaining that banks have cornered the aluminum market with 70 percent holdings. They’re buying the metal, selling it forward at higher prices, and storing it on the cheap until they can profit from it.

Rising prices are good for investors, but they also mean increased prices on the retail side. When consumers go to buy coffee, they see increased prices at the counter. The same holds true with purchasing cars, if the aluminum market is being bid up.

Why Commodities Traders Do What They Do

The simple answer is that commodities speculators are in it for one thing and one thing only: profit. Commodities speculators believe that certain commodities are underpriced. They see an opportunity to buy the commodity and they jump on it. If the rest of the market agrees, then the price gets bid up, much to the dismay of businesses and individuals that rely on those commodities.

What about cornering markets? It takes a large trader to buy up a substantial portion of the market. Usually, it’s impossible. When it does happen, the market still has a mechanism built into it for correction.

Enter Short Sellers

Sometimes commodity speculators get it wrong. It’s not pleasant to see increased gasoline prices, coffee prices, and even prices for your favorite food go up. It’s especially difficult to see those prices increasing during a recession. You may not be able to afford those increases, and your only hope (aside from government regulators) is traders waiting patiently on the other side of the trading fence.

While commodities speculators can temporarily bid up the price of any commodity, short sellers act as gatekeepers and monitor other speculators. If the price is bid up too high, short sellers come to the rescue and bid the price back down. They do this by borrowing the rights to the commodity in question. This creates downward pressure on the price of the commodity. The short seller then waits for the price of the commodity to fall. When it does, he sells when he thinks it has reached its “intrinsic” value.

While all of this is going on, consumers and businesses might be kept in the dark. It takes a special kind of individual to understand how the commodities market works, and a lot of skill to trade it effectively. Short selling is especially complex, and without understanding the mechanics of how speculation works, many consumers are left wondering why prices for things they love to buy seem to skyrocket inexplicably. Your best defense against speculation is to stock up on things that you think will rapidly increase in price before the bidding takes off.

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